Perfect Your Exit Strategy

07/07/2017By Sammy Abdullah, CFA

Recently an investment banker named Tom Metz was kind of enough to share his book with me entitled “Perfect Your Exit Strategy”. It’s about preparing and going through an exit with an investment banker and I found it to be very insightful. Below are direct quotes from Tom that I found most informative. It’s well worth the read and Tom can be reached at tom@tvmetz.com.

Get Moving

Business owners should begin thinking about their exit strategies two to four years ahead of time.

Management Motives

The second reason to sell involves management. The company may have outgrown the founder’s skill set. A hired CEO may be struggling to grow the company. Personality clashes may exist within the management team.

Growth and Market Traction Problems

The best time to sell is when the company is doing well and enjoying excellent growth and profitability. This is when the firm can sell for top dollar. Of course, few businesses want to sell when this is the case. They are enjoying the ride. Companies usually want to wait for the growth to slow before selling. In my experience, companies usually wait too long before deciding to sell.

Market Timing Issues

Contrary to what you may think, the best time to sell may not be when the company is at the top of its game or when revenues have peaked, but when the buyers desire your company the most – when the market is hot. This is when a buyer will pay top dollar.

Think about the opposite situation – the likely acquirers have acquired other solutions or developed their own products. This is the problem when companies wait too long and it can have a negative impact on price.

Why Not to Sell

… the company should continue building when the value being created outweighs the risks of staying independent.

Strategic Value, a.k.a Secret Sauce

Time is often a component of strategic transactions. A buyer may want a particular technology immediately because of market conditions or competitive pressures. A company may be willing to pay a premium if it can acquire the technology now.

Strategic transactions are unique; therefore it is not legitimate to compare one with another. This is another reason that multiples of revenue are inappropriate.

Large Buyers

One of the mistakes that I have seen over the years is that small companies believe that the largest companies are the best buyers for them. As a result, they end up focusing on the wrong companies. It is much better to focus on the midsized and smaller buyers even though these companies are not as visible.

A small acquisition will rarely make an impact on a $1 billion company. So unless your company has revenues greater than about $30 million, it is not productive to reach out to large buyers. It is simply too small to get their attention.

Midsized Buyers

An acquisition is an excellent way for a midsized company (with revenues from $150 million to $500 million) to add capabilities and expand into new markets. A midsized buyer acts a lot like a big buyer; however, the midsized buyer will consider a small acquisition of $10 million or $20 million if it achieves a strategic objective.

Small Buyers

Small buyers are best for small acquisitions. A $5 million or $10 million acquisition is an important transaction for a small buyer.

Competitors as Buyers

Competitors are rarely the best buyers. Even if the seller’s technology is superior, it is unlikely that the competitor will replace its current technology with the seller’s technology.

Consolidation is the typical reason behind acquisitions made by competitors. Acquisitions in a consolidating industry are usually made to gain customers. These types of transactions generally do not pay high prices because the customers are the only real asset.

Who are the Best Buyers?

Many times the best buyers are not in the selling company’s primary market; they are in adjacent markets. In addition, the best buyer may not be the first company that makes you an offer.

Get the Employment Agreements Right

New employees should sign noncompete agreements too. Most buyers will want senior and technical employees to have signed a good, modern employment agreement.

Minimize Potential Liabilities

As mentioned earlier, potential litigation is almost always a deal killer. If you have any potential litigation, do everything in your power to settle or eliminate this issue before you begin the process of selling the company.

Dealing with Problem Areas

The buyer will eventually find out anything and everything about your company so upfront honesty will go a long way. You might as well be frank about it. There are no perfect companies. Being straightforward will help build a relationship with the buyer based on truthfulness and this is a good thing.

The Nonobvious Buyers

Sometimes the best buyers are not in a company’s core market space, but in the little spaces off to the side, in neighboring areas. Don’t assume that you know who the best buyers are. Sometime nonobvious buyers in adjacent markets can be excellent buyers.

Rapid Response – Contact 5 to 10 Companies

The rapid response involves immediately contacting a handful of likely candidates. The idea is to get several competitive bids as soon as possible so as not to impair the relationship with the first bidder.

Potential Problem Areas

Almost every deal blows up at least once. After verbal agreement, there is only about a 60% chance of successfully closing the transaction.

Customer Issues
It is critical to stay close to your customers. My advice is to be up front with your most important customers and inform them fairly early of your decision to sell. The buyer will definitely want to speak with key customers. The earlier the customer is advised of the situation the better off they will feel

Confusing Price with Value

Multiples of revenue are irrelevant. A buyer may speak in terms of revenue multiples but they do not think in terms of revenue multiples.

Unrealistic Price Expectations

Unseasoned negotiators make the mistake of thinking that if they ask a high price, they will be more likely to obtain a high price. This is rarely the case … My advice is to get as many offers as you can and then take the highest one.

Trying to Sell at the Top

The ideal time to sell is when the larger companies have the greatest need to acquire your company; when they want your business, assets or technology. Trying to pick the top usually results in missing the window and not selling for the optimal price.

Too many CEOs think about value in financial terms, not strategic terms. The mindset is: “If we wait, we will be worth more.” For technology firms, the strategic value is typically greater than the financial value so waiting does not necessarily increase the value.

Waiting Too Long to Sell

Waiting for better financial performance is not usually a good plan. For a company with strategic value, the buyer is seeking technology and capabilities, not revenues or cash flow.

Not Engaging a Professional

An objective third party can help defuse unreasonable claims, establish a constructive atmosphere and minimize extreme posturing. Friction can develop in negotiations. To avoid an adversarial relationship, let an intermediary handle the negotiations and be the bad guy.

Poor Negotiation Problem Solving

About 40% of transactions fall apart at least once. Poorly solved problems can delay a transaction or result in a suboptimal structure.

Why Companies Do Not Sell

Timing is important. The first company in a market space to be acquired has an advantage because it has a solution that potential buyers need. If a company tries to sell too late, potential buyers may have already developed solutions. The lesson for management is to keep a sharp eye on competitive solutions in your market.

Communicating With Customers

Informing customers is a judgment call on management’s part. It is probably best to inform your major customers.

Communicating with Employees

Employees are vital assets for most companies and it is imperative that they stay on board during the transaction process. It is a good idea to put retention bonuses in place to give management and key employees an incentive to stay on board.

It is difficult to keep a secret like this for long. In my opinion, the best policy is for management to be open and honest with employees fairly early in the process.

The Letter of Intent

In addition to the basic price and terms, the LOI includes information about not hiring away employees and a no-shop clause. In the no-hire clause the buyer promises not to try to hire any of the seller’s employees.

Transaction Structures

Transactions larger than $25 million are usually structured as a sale of stock. Smaller transactions are often structured as a sale of assets. This is not a hard and fast rule;

Sale of Assets

Buyers prefer to purchase assets on small transactions because it reduces the possibility of unknown liabilities.

The C Corporation itself must pay taxes on the gain for a sale of assets and then the shareholders must pay taxes when they receive the proceeds from the sale.

In one transaction that I was involved in, the deal actually fell apart because the buyer wanted to purchase assets, not stock. The selling company was a C Corporation and it had to pay taxes on the gain and then the three founders had to pay additional taxes on individually.

Assuming Liabilities

It makes sense for the buyer to assume accounts payable – because it wants to make sure the bills are paid. The buyer wants to maintain good relationships with the customers so it will usually assume the accounts receivable and any service contract liabilities. The buyer will not assumer past payroll obligation, deferred compensation or professional fees.

Forms of Payment

If a company trades its stock for stock of the buyer, the transaction will be tax free in most situations. If stock is sold for cash, the shareholders will have to pay taxes on the capital gain.

Consulting Contracts and Noncompetes

Consulting contracts are made with key management people to help with the transaction period. These contracts typically last from six months to as long as two years.

Noncompete agreements are standard in the sale of companies. By signing a noncompete agreement, an employee agrees not to work for a competitor for a period of time

Earnouts

An earnout can be a versatile tool to bridge the price gap between what a seller thinks his company is worth and what the buyer is willing to pay. In other words, they can’t agree on price.

Tax Planning

The buyer and seller must use the same amounts for each allocation. Generally, what is good for the buyer is bad for the seller and vice versa.